Just curious, given how heavily from Tolkien D&D drew, and the fact that games like Wizardry used Hobbits, is there a good design reason why Gygax and company used Halflings (a term that also appears in Tolkien) vice Hobbits as the term for our little friends?

Halflings were originally called hobbits prior to a legal challenge.

TSR was served with papers threatening damages to the tune of half a mil by the Saul Zantes (sp?) division of Elan Merchandising on behalf of the tolkien Estate. The main objection was to the boardgame we were publishing, The Battle of Five Armies. The author of that game had given us a letter from his attorney claiming the work was grandfathered because it was published after the copyrights for JRRT's works had lapsed and before any renewals were made. The action also demanded we remove balrog, dragon, dwarf, elf, ent, goblin, hobbit, orc, and warg from the D&D game. Although only balrog and warg were unique names we agreed to hobbit as well, kept the rest, of course. The boardgame was dumped, and thus the suit was settled out of court at that.

Halflings were originally called "hobbits" in the Dungeons & Dragons box set first released in 1974. Later printings changed this to "halfling".

According to The Acaceum, this change occurred between the fifth printing (Dec 1975 - Apr 1976) and sixth printing (1977), with the six printing being marked the Original Collector's Edition. However, Tim Kask has said that box sets were generally thrown together with whichever printings of the books were on hand, so the distinctions between printings are inexact. The Acaceum notes at least one box set shipped having the revised booklets but no Original Collector's Edition mark.

According to Wikipedia, J.R.R. Tolkien sold the film, stage, and merchandising rights to The Hobbit and Lord of the Rings to United Artists in 1968, who sold them in turn to Saul Zaentz in 1976. Zaents would go on to produce the 1978 Lord of the Rings animated movie.